How much can you make in stocks? Realistic Expectations (ICMA Retirement Corporation)

Charts of the Week

Capital Markets Review (As of 9/30/2015)

Chart of the Week for October 2, 2015 - October 8, 2015

Capital market returns were generally negative in the third quarter of 2015, with the exception of U.S. Bonds which had slightly positive returns as U.S interest rates fell during the quarter. Over the trailing 1-year period, U.S. Bonds and U.S. Small-Cap Stocks provided positive returns while International Developed Market Stocks, Emerging Market Stocks, U.S Large-Cap Stocks, and U.S. High Yield Bonds all had negative returns. Over the trailing 5-year period, all asset classes shown except Emerging Market Stocks had positive returns, with U.S. Large- and Small-Cap Stocks outperforming the other asset classes shown.

While U.S. economic reports were generally positive for the third quarter, the negative returns for the asset classes shown above can be related to several factors including market volatility, concerns over economic conditions in China, and U.S. interest rate policy. Emerging Market Stocks was the worst performer in U.S. dollar terms, losing 17.90%. U.S. Small-Cap Stocks lost 11.92%, International Developed Market Stocks lost 10.23%, U.S. Large-Cap Stocks lost 6.44%, and U.S. High Yield Bonds lost 4.86%. U.S. Bonds was the only asset class with positive returns noted on the chart for the quarter, wtih a return of 1.23%.

In the chart above:

• U.S. Bonds are represented by the Barclays U.S. Aggregate Bond Index.
• U.S. High Yield Bonds are represented by the Barclays U.S. Corporate High Yield Index.
• U.S. Large-Cap Stocks are represented by the S&P 500 Index.
• U.S. Small-Cap Stocks are represented by the Russell 2000 Index.
• International Developed Market Stocks are represented by the MSCI EAFE (Net) Index.
• Emerging Market Stocks are represented by the MSCI Emerging Markets (Net) Index.

Stocks, Bonds, Cash and Inflation - the last 30 years

Chart of the Week for March 30, 2012 - April 5, 2012

When investing in any asset class, such as stocks, bonds or cash equivalents (U.S. 30 Day Treasury Bills), an investor assumes some level of risk. Securities with higher return potential typically carry more risk of not meeting return expectations or even possibly losing some or all of the amount invested. Stocks, for example, are typically more risky than bonds or cash equivalents, but have historically offered higher return possibilities. The graph above illustrates the relationship between risk and reward in different asset classes between February 1982 and February 2012.

We can see the growth of inflation and of a $1 invested in three different asset classes beginning at the end of February 1982. After 30 years, the $1 invested in stocks, as measured by the S&P 500 Index, would have grown to $26.56. If that same $1 was invested in bonds, as measured by the U.S. Long-Term Government Index, the investment would be worth $22.03. If the $1 was allocated completely to cash equivalents, represented by U.S. 30 Day T-Bills, its value would be $3.84, only slightly better than inflation. As a result of inflation, $2.40 is needed in February 2012 just to buy what $1.00 bought in February 1982.

Over the 30 year period, stocks outperformed bonds and cash equivalents, and stayed well ahead of inflation. However, stocks carried the most risk as demonstrated by the volatility in the blue line and if the chart stopped in December 2008, bonds outperformed stocks. Depending on your risk tolerance, time horizon, and investing goals, each investor should balance risk and reward to create their own portfolio. Remember the next 30 years may not look like the last 30 years.



© Copyright 2012 ICMA Retirement Corporation, All Rights Reserved. This information is intended for educational purposes only and is not to be construed as investment advice or a solicitation to buy or sell securities. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed here. Past performance is not necessarily indicative of future performance.

How to Recognize the Next Bull Market ( Futures Magazine)

Four stages of a bull market and how to profit - Financials - Futures Magazine


More money is likely made from bull markets than any other market condition. Understanding how to invest during these periods is key to long-term success. First, a simple definition: A bull market is a congestive market composed of an extended period of time in which the stock indexes continue to register higher highs. It is composed of four periods. Two of those four periods are relatively easy to identify, while the first and fourth periods are a blending of the bull and bear cycles and are more difficult to spot.

These periods are often difficult to define clearly because they are normally rife with conflict. The cycles never change from black to white or white to black, but rather evolve in stages of gray. One of the skills of reading the market is to be able to interpret this gray as it develops and to identify the actual reversal points before they become clear to the general public.

Although they often look orderly in retrospect, bull markets are less clear as they unfold. They take two steps forward and one step back. Bull markets normally stagger around with little discernible direction. During the bull cycle, 90% of all stocks will slowly follow the 100-day moving average north. The problem is that they tend to check out every side road and rest area in the process. Although bull cycles occasionally develop strong trends, they are normally identified by continuation patterns.

Scaling outward helps. Just like a bear market, these markets can be confirmed by observing an 18-month simple moving average (see "Riding the bear," Futures, June 2009). This occurred in the present cycle in October.



Period one

The first period of a bull market is marked by little, if any, public confidence and quiet accumulation by professionals. It is nearly impossible to identify this stage as it is happening. However, good fundamentals, improving earnings and bargain prices mark this as a period of accumulation by value buyers and institutions.

As this period develops, traditional reversal patterns in individual equities begin to appear. The average price is low and even the good stocks are cheap. Also, the price/earnings (P/E) ratios of the indexes are low. A few strong stocks now begin to break out of their sideways patterns. At the same time, isolated weekly and monthly highs occur as prices begin crossing their 100-day moving averages.
On balance, price action is dull and volume is low. While the violation of the 18-period moving average may have indicated a turning point in the overall market, it is not a guarantee that a particular stock will rebound soon. Many former market darlings will lie dormant for years.

Leading money managers now begin their accumulations based on the fundamentals. Because disillusionment with the market is the general temper of the public, good buying opportunities are abundant. Many companies with solid business strategies and strong competitive positions within their individual sectors offer real potential for price appreciation. Because most of those who found themselves in desperate need to sell have already done so, the supply is somewhat diminished. Therefore, to get strong stocks, traders now have to start giving higher prices to acquire them. Caution is still driving the bus.

Nevertheless, although values are good and the institutions are pursuing quiet accumulation, the public will not be back into stocks until they reach much higher prices. Most of the bottom pickers were slaughtered on the way down, and the reality is that there are only a limited number of players left.

Most people consider price as the determining factor that indicates the end of a bear market, but it really is time and fundamentals. For this reason, bottoms take much longer to form than it does for tops to collapse. Nowhere is this more apparent than in the opening stage of a bull market, and this is why it is hard to tell when you are in the first stage of a bull cycle and not in a bear market rally.

If you are looking for individual stock picks during this period, it is a good idea to watch for ones with good P/E ratios and return on equity values as they cross their 200-day moving averages.




Period two

In the second stage of a bull market, stock prices have been rising for several months and the mark-up is ready to commence in earnest. Market-leading equities are beginning to violate their 200-day moving averages. This is the time to buy the dips and ride the rallies higher.

Market newsletter writers and television pundits to the contrary, there is no magic in picking stocks in this period. In fact, you can pretty much select any stock and it will appreciate — the only question is by how much. If you are looking for individual stock picks during this period, it is a good idea to prospect the new highs found within the most-active lists.

Because money follows rallies, greed has been rekindled and more people are starting to think of the stock market as a wealth generator. Now there is competition by the public for a reduced supply, and accumulation is forcing prices higher. Some market participants are starting to show some impressive profits due to having bought early and simply holding. However, the larger public does not join the party just yet. Keep in mind that bull cycles take time to develop.

Market leaders are now rising to the top and the media loves them. Mutual fund inflows are increasing once it is apparent that the market is recovering. The Dow Jones Transportation Index now clearly reverses. It all comes down to markets being driven by liquidity and nothing else. Rallies are not caused by inflows, but rather inflows are the result of rallies — and rallies are the result of a series of higher highs. All of this is another way of spelling "greed."

Remember that it is not public demand that causes rising prices but the rising prices that cause public demand. The conclusion of this period is often marked by a significant retracement as the market pauses to catch its breath. However, too much greed is present for prices not to continue rising. As this retracement occurs, it is time to remember that bases must be built for the bull cycle to continue. Things are now getting in line for the third stage. Greed is driving the bus.


Period three

During this period, stock prices advance at a phenomenal rate. Cocktail parties are full of people with "hot tips." Most of the market participants are looking for easy money and little attention is paid to the underlying fundamentals of the larger market.

P/E ratios begin to achieve ever-higher levels, but that is immaterial. New stock market experts look upon all traditional fundamentals with disdain. Historical experiences are scorned, and the mantra of the day is that "it is different this time." New books about how to make millions in the stock market are common and fundamentals really do not seem to matter to anyone anymore.

About now, an initial public offering (IPO) craze hits the market. During period three, a plethora of new companies are formed to satisfy a public’s insatiable appetite for stocks of all kinds. The reason behind this is simple: There is more money to invest than there are shares available to sell.

In addition, a merger-mania also develops and buy-outs run rampant through corporate finance. The availability of leverage funds makes this possible. In other words, many companies are enjoying bloated stock prices to aid in the facilitation of any acquisition that might arouse corporate interest. As long as companies can convince others that their stock prices are valid, acquisitions are easy. Public relations and spin are now driving the bus.
Many leading issues actually will reach their highs during this period. They will then reverse long before the overall market shows any inclination to do so. This always leads to the last stage of a bull market and distribution begins. The professionals start to distribute some of the shares that were acquired in period one.


Period four

The main factors that have been leading the market to period four — and the coming market collapse — have been uneducated speculating and unrestrained leverage, both of which were aided by easy credit. This is finally becoming apparent to even the most unsophisticated market participants. Period four is rife with conflict and confusion. Slogans such as "if you would have put $10,000 in the market 50 years ago and never sold, you’d be a multi-millionaire today" are now common.

The market develops a theme. These themes culminate into an obvious bubble as the market seizes upon the theme and then goes slightly mad with it. These bubbles float on a sea of easy credit and greed and are rabidly pursued by the public as they dump ever more money into it.

We can go back over market history for hundreds of years and we will find bubble after bubble. There is one about every 20 years or so. These bubbles always are connected by corrective recessions or depressions but like the phoenix, a new bubble always springs forth from the ashes of the old as a new theme develops.

There has been the technology boom, where any company that had "tech" in its name was viewed as an instant path to riches. Then came the "nifty 50" where buying any of 50 blue chips stocks was considered a guaranteed path to wealth. The "conglomerate boom" was so volatile that it became the main concern of the academia that America was going to end up with only five to 10 public companies. Then came the "Internet boom" where all of the stores in America were going to close and people were going to buy everything, including their cat’s food, off of the Web. This incomplete list is to say nothing of the several real estate and commodity bubbles that connected them.

Normally, a bull market’s resolution is not the result of some cataclysmic occurrence or the result of a mature market, as the uninitiated tend to believe. It is the simple result of the inability to keep more and more money coming into the market. In other words, the market suffers from a shortage of players.

This is a period of high volume, high volatility and extreme vacillation. Profits achieved during period two and three have confirmed the belief of most investors that the bull market will continue forever. For these, the start of the upcoming decline is viewed as a gigantic buying opportunity. The truth is, those who see the lower prices as bargains are now the only ones sustaining the bull market. As prices continue to creep lower, the professional traders continue to sell into every rally. Clowns are driving the bus.

The market now begins to eat its own tail, effectively destroying any chance of the bull cycle continuing. We see many market-leading stocks react several points from their previous tops and then not retrace. Their race is obviously run. The best advice: When the press becomes euphorically bullish, but the cumulative advance/decline lines on the weekly chart of the indexes do not concur, tighten your stops, reduce your exposure and tread carefully.



The Tacoma Narrows

Anytime prices begin to print irrationally and your oscillators won’t behave, it is a head’s up to be careful. Extreme vacillation of price usually indicates that something is badly out of balance. Therefore, be wary of any market that seems unwilling to print decent charts. If a market won’t settle down and behave, the likelihood is that it is coming apart. Vacillation of the larger market indicates that something is seriously wrong. It is just that it is not widely apparent, at least not yet.

Whenever you see extreme vacillation in the larger market, it is a good time to remember the story of the Tacoma Narrows Bridge. In 1939, a bridge was built across the Columbia River at a place known as the Tacoma Narrows. Its purpose was to connect Portland, Ore., and Tacoma, Wash.

Unfortunately, the engineers never took the wind sheer of the river into consideration when they designed the bridge. After it was completed and in use, the wind forces created by the Columbia Gorge would whip the bridge up and down and side to side violently, eight to 20 feet at a time. In other words, the bridge was unstable. Although the bridge did not immediately fail, it should have been obvious to anybody who saw it that something was not right.

Nevertheless, it did not make much difference to the public. Despite the obvious weakness of the bridge, people continued to drive on it, walk across it and get their pictures taken while standing in the middle of it as it gyrated wildly above the river. They did this for over four months knowing full well that something was amiss. Fortunately, no one was killed in 1940, when the wind finally twisted the bridge badly enough that it broke up and fell 100 feet into the Columbia River.

As an interesting aside, starting with the year 1900, the length of the average bull cycle has been 40 months and three weeks, which is probably close enough for land mines and hand grenades. It should be noted that during a bull market, approximately 90% of all stocks follow the 100-day moving average higher.


Aubrae DeBuse has been engaged with the markets off and on since 1959 and is presently a proprietary trader for a family foundation.

Bargains in Emerging Markets (from Smartmoney.com)

As the U.S. struggles to reverse the economic slide, some emerging markets are ahead of the game. The International Monetary Fund projects that while the world’s advanced economies will contract this year, emerging economies will expand by as much as 2.5 percent, and some countries will grow a lot faster. Even better news: Some pros are finding they don’t have to pay a lot to own profitable foreign stocks. The valuations on foreign stocks have become “very, very attractive,” says Uri Landesman, chief equity strategist for asset manager ING Investment Management Americas.

It was only two years ago that investors plowed more than $16 billion into emerging-market mutual funds, trying to find the next big Chinese Internet start-up or Russian coal mine. Unfortunately, like many investing trends, a lot of people piled into emerging-market stocks just as they peaked. Growth did slow around the world, and the stocks tanked. Even with this spring’s market rally, emerging-market stocks, as a group, have lost more than 40 percent since October 2007.
However, many of these nations are not mired in the housing market disasters that plague wealthier countries, and their banking systems are healthier as a consequence. Meanwhile, millions of people in these nations are moving into their middle class. The fortunes of these countries aren’t completely beholden to the health of the U.S. economy, either. China’s economy, for example, is expected to grow at least 5 percent in 2009.
For decades, stocks in China, Chile and other emerging nations traded at a significant discount to their American counterparts. By mid-2007, some were trading at a premium. The market wipeout brought emerging-market valuations closer to their normal discount. Of course, that return to normal cost some investors a lot of money, but the lower prices could give new investors a chance to buy into growing nations at a more reasonable price.
Here are five picks—all of which are listed on U.S. stock exchanges.

China Mobile
More than 160 million mobile phones were purchased in China in 2008, and analysts expect that number to grow another 5 percent this year. That bodes well for Hong Kong-based China Mobile, which has almost 75 percent market share of mobile-phone service in China. It has 470 million subscribers—a throng 50 percent larger than the entire U.S. population. Amazingly, analysts estimate there are still several hundred million Chinese who don’t yet have a mobile phone but eventually could. In the short term, if cash-strapped consumers are forced to choose between a landline and a mobile phone, they usually opt to go wireless, says Phil Kendall, director of the global wireless practice at market research firm Strategy Analytics.

The Chinese government restructured the country’s phone industry last year, allowing its biggest landline company, China Telecom, to join a wireless market formerly occupied by just China Mobile (CHL: 50.74*, +0.06, +0.11%) and China Unicom. But even with the competition, China Mobile’s dominant market position allows the company to negotiate favorable rates with vendors. In 2007 the company launched its own instant-messaging system for its phones, allowing it to keep more revenue than if it used a system made by Microsoft or another firm.

China Mobile’s stock trades at about 11 times 2010’s expected profits, well below its 10-year average price/earnings ratio of more than 24. China Mobile has said the sluggish economy and increased competition will temper its growth this year, but it will still grow. Many analysts remain confident the company will continue to increase revenue and profits steadily over the next several years, global recession or not. In the meantime, the stock has a 3.9 percent dividend yield, so investors are paid to wait for the economy to improve.

HDFC Bank
Many of the senior executives of Mumbai-based HDFC Bank (HDB: 101.20*, -0.83, -0.81%) are native Indians who worked for Citibank and other Western banks outside India. But when they opened their bank in 1995, when there were very few private banks in India, they came home to serve Indian customers. As banks worldwide loaded their balance sheets with exotic, risky mortgages, HDFC stuck with serving India’s burgeoning middle class. About 70 percent of HDFC’s revenue still comes from plain old retail banking, like issuing credit cards and loaning money to small businesses. That has kept it from having to take write-downs that burdened many other banks, says Ferrill Roll, portfolio manager for Harding Loevner, which owns HDFC shares.

HDFC’s toughest competition is from state-owned banks. While HDFC branches offer more efficient service, according to analysts, state-run banks reach much more of India’s 1.1 billion population. In India, government banks carry the perception of increased safety, and consumers worldwide find it annoying to switch banks.

Despite these challenges, HDFC is well positioned to attract new customers. Over the next two decades, the country’s middle class will grow from about 5 percent of the population to more than 40 percent, creating the world’s fifth-largest consumer market, according to McKinsey & Co. Assuming HDFC keeps up its superior customer service, it stands to capture a large share of this new market.

HDFC shares have rallied sharply in recent weeks, so investors might want to wait for a pullback before buying. With a P/E ratio of 21 times next year’s estimated earnings of $590 million, HDFC is not the cheapest bank stock. But analysts expect the bank to increase profits 25 percent in its fiscal 2010 (which started in April) and another 26 percent in fiscal 2011. “It’s one of the best-managed banks in the world,” says Cabot Money Management’s Lutts, who also owns the stock.


Vale
The booming economies of China, India and other emerging nations gave mining firm Vale (VALE: 19.24*, -0.13, -0.67%) years of spectacular profit and revenue growth, solidifying its position as one of Brazil’s largest companies and the world’s largest producer of iron ore. Vale’s main competitive advantage over rivals BHP Billiton of Australia and English firm Rio Tinto is its top-quality, plentiful iron ore deposits, says Tony Robson, cohead of mining research at BMO Capital Markets. China is the biggest market for Vale’s iron ore, accounting for more than 17 percent of the company’s revenue. China’s steel production (iron ore is a primary component of steel) is expected to decline only slightly this year, thanks to the nation’s quick implementation of an infrastructure-focused economic stimulus package, says Jorge Beristain, head of Americas metals and mining research for Deutsche Bank Securities. Vale has expanded its client base in China, adding small and medium-size steel mills to compensate for the reduced demand from the larger mills. Vale CEO Roger Agnelli has said he expects iron ore exports to China to hold steady for the rest of 2009.


Still, the global downturn has forced the Rio de Janeiro–based firm to scale back projects and cancel some others, and the company recently cut its capital spending plans for 200 to $9 billion from $14 billion. Investors have pounded down Vale’s shares over the past year as the price of iron ore has tumbled. Longer term, however, many analysts are confident that Vale will benefit from an economic recovery worldwide. In the meantime, the stock trades at 13 times this year’s expected profits of $8.5 billion.


SQM
It certainly helps any company to have a corner on the market. Half the customers who buy specialty fertilizer from Chile’s Sociedad Química y Minera de Chile (SQM: 36.26*, -0.59, -1.60%) can’t easily substitute anything else for the product, says Brian Chase, head of Southern Cone and Andean Equity Research and Strategy for J.P. Morgan. Crops such as tobacco, wine grapes and blueberries need special fertilizers that only SQM can provide in the region.

Much of SQM’s competitive advantage comes from its access to the Atacama Salt desert in Chile, land rich with nitrates, iodine, potash and lithium, all useful in fertilizer production. Besides having a monopoly on fertilizer in Chile, SQM also claims a 30 percent share of the world’s market for lithium (used in hybrid-car batteries) and 33 percent market share of iodine (used in X-ray dye and LCD televisions). Asia accounted for 15 percent of SQM’s $1.8 billion in revenue last year, and Chase expects that share to rise as China increases its fertilizer imports to help feed its people.

SQM is not immune to the global downturn, of course. Many fertilizer stocks, including SQM’s, fell dramatically in the second half of 2008 as fertilizer prices dropped. Yet demand for the company’s all-organic fertilizer should continue to grow. Farmers need to use organic fertilizer to have their fruits and vegetables certified as organic by the U.S. Department of Agriculture and similar government bodies in other countries. Demand for high-end fertilizer might actually increase in an economic slowdown, as people eat at home more and seek out high-quality ingredients, says Jim O’Leary, manager of the Touchstone International fund.

Analysts predict a modest bump in SQM’s earnings this year over last. In 2008, SQM posted earnings of $501 million, a 179 percent increase over 2007 earnings. Don’t expect such a monster gain this year, but analysts still predict a 14 percent gain in profits. The stock trades at about 22 times estimated earnings of $627 million, about its 10-year average P/E.

CNOOC
As the global economy slowed and the price of oil tanked over the past year, oil companies around the world pulled back on drilling for crude. But that’s not the case with China National Offshore Oil Corp., the giant firm that brings up oil from, you guessed it, the ocean waters off the coast of China. The firm, commonly known as CNOOC (pronounced see-nook) is increasing its capital spending by 19 percent in 2009, to $6.8 billion. The company can sell anything it brings up from the ocean floor. In fact, Hong Kong–based CNOOC (CEO: 141.35*, +0.28, +0.19%) sells oil to its major Chinese rivals because the other two can’t produce enough on their own.

CNOOC is majority-owned by the Chinese government. It teams up with major oil companies that have the expertise to build and operate offshore drilling platforms. When they find oil, CNOOC shares in the profits. When they don’t, the foreign companies bear all the costs.

Don’t expect its profits to be even close to the $6.4 billion in made in 2008, however, because the price of oil has fallen to around $60 from its $147 peak last July. CNOOC has no refining business, so its profits are tied almost exclusively to the price of crude. Still, it cost the company, on average, only about $20 to bring up a barrel of oil from the sea in 2008, Xiao Zongwei, CNOOC’s general manager of investor relations, told SmartMoney. So even if the price of oil resumes its descent, CNOOC should yield fatter profit margins relative to other oil companies, says Steve Cao, comanager of the AIM Developing Markets fund, which also owns the stock.

At nearly 16 times this year’s lower profits, CNOOC is not a steal. But some analysts feel that its growth prospects over the long term should command a premium. China’s fuel needs will only rise as the country’s growing middle class hits the road in its new cars, analysts say.

Investing - the New Normal (Bloomberg Opinion)

Gross, Grantham, Bogle Lift Lid on ‘New Normal’: John F. Wasik



Commentary by John F. Wasik

June 1 (Bloomberg) -- If this past year has taught investors anything, it is that conventional wisdom has suffered a thousand cuts.

Stocks don’t always beat bonds. It may not make sense to always have 60 percent or more in stocks and 40 percent in bonds. Stock markets may actually reward politicians.

Three pallbearers of the established canon are Bill Gross, the co-chief investment officer of Pacific Investment Management Co.; Jeremy Grantham, chairman of GMO LLC; and John Bogle, founder of Vanguard Group.

All are beacons in a troubled industry. When I caught their talks at the Morningstar Inc. investment conference in Chicago on May 28, I expected to hear dour forecasts. Yet I didn’t expect notes on the revolution that is undermining the beliefs that investors held during growth eras.

Gross, the world’s most successful bond-fund manager, described what his firm calls the “new normal” investing environment. While he sees “accelerating inflation” toward the latter part of a three- to five-year cycle, he says almost every accepted notion about investing should be examined.

Weak earnings growth translates into “getting used to a 301(k)” -- as opposed to a robust 401(k) -- retirement fund. Stocks won’t always outperform bonds and having dominant positions in equities may not make sense.
Changing Outlook

In Gross’s outlook, the dollar will lose its status as the reserve currency; Brazil, India and China (forget Russia) will offer the best growth; and the U.S. is “consumed out.”

“Everything in this new normal world should be questioned,” Gross said.

What is normal? Certainly not an environment that rewarded investors with 10 percent returns in stocks every year as Wall Street said it would before the dot-com, housing and credit crashes dashed that myth.

That means the accepted wisdom of having 60 percent to 80 percent in stocks may be obsolete and unprofitable. The only guarantees are that the U.S. government will be selling trillions in Treasuries; Americans may start seriously saving again; and the consumer economy may be shrinking long term due to the aging of the population.

Grantham, whose bearish views can often be amusing in the way he presents them, sees some reasonable values in the stock market now, although he’s not sure that a robust rally is in the offing. He also warns that “you can bet on” a bubble forming in emerging-markets stocks.
Grantham’s Optimism

Like many observers, Grantham also sees Americans saving more and consuming less.

“We forgot to save in the last decade because of home prices,” he said. “Now we’ll have to work longer and be more frugal in order to retire.”

Grantham’s only palpable stock-market optimism -- always in short supply in his forecasts -- is the third year of a U.S. presidential cycle.

“Historically, year three has outperformed years one and two by about 22 percent,” he noted. “And there’s never been a major bear market in year three of a presidential cycle.”

For most of us stung by the wretched returns of last year, though, 2011 is too long to wait. That’s why I prefer Bogle’s fundamental approach to portfolios. It doesn’t involve any charts and almost no forecasts.

Bogle says his formula is based on one’s age. The older you are, the more you should have in bonds, approximately matching a percentage of fixed-income investments to your age.

Sage Advice

As one who mostly takes his own advice, Bogle said his allocation produced only an 11 percent loss in his portfolio last year when others with higher percentages in stocks lost from 30 percent to 50 percent.
Of those who got scorched last year, “98 percent of all investors would be willing to swap places with me,” Bogle said.

In keeping with his bedrock views that passive investing through low-cost index funds prevails over time, Bogle eschews absolute return and commodity funds.

What each sage investor neglected to mention was an ever- greater need to customize portfolios not only to hedge market risks but personal labor-market risks as well.

Are you in a profession or industry that’s wobbly right now? Do you have the resources to retrain or re-educate yourself? At the very least, your savings and investments should support some vocational flexibility in these dynamic times.
That’s perhaps the only piece of conventional wisdom that hasn’t changed.

(John F. Wasik, author of “The Cul-de-Sac Syndrome,” is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John F. Wasik in Chicago at jwasik@bloomberg.net.

Last Updated: June 1, 2009 00:00 EDT

Outlook for 2009 from RGE monitor - predicting a LONG Recession

RGE Monitor - 2009 U.S. Economic Outlook

Christian Menegatti, Arpitha Bykere, Elisa Parisi-Capone and Mikka Pineda | Jan 7, 2009

It is clear that 2008 was not a very good year and it is official that the current U.S. recession started already in December 2007. So how far are we into this recession that has already lasted longer than the previous two (1990 and 2001 recessions lasted 8 months each)? We believe the U.S. economy is only half way through a recession that will be the longest and most severe in the post war period. U.S. GDP will continue to contract throughout 2009 for a cumulative output loss of 5% and a recession that will last close to two years.

One last look at 2008 will reveal a very weak fourth quarter with GDP growth contracting -6%, in the wake of a sharp fall in personal consumption and private domestic investments. We see the real GDP growth contraction playing out through the year as follows: Q1 2009 -5%; Q2 2009 -4%; Q3 2009. -2.5%; Q4 2009 -1%, adding up to a yearly real GDP growth of -3.4% for the U.S. in 2009.

Personal Consumption

The resilient U.S. consumer started to give up in the third quarter of 2008, when for the first time in almost two decades, personal consumption contracted. With personal consumption making up over two-thirds of aggregate demand, the outlook for the U.S. consumer is at the center of the dynamics that will play out in the real economy in 2009.

In our view, personal consumption will continue to contract throughout 2009 quite sharply as a result of negative wealth effects from housing and equity market losses, the disappearance of home equity withdrawal from the second half of 2008, mounting job losses, tighter credit conditions and high debt servicing ratios (the debt to income ratio went from 70% in the 90s, to 100% in 2000 to 140% now). This retrenchment of the U.S. consumer will result in a painful rebalancing in the economy that will eventually restore the saving rate of a decade ago.

The wealth losses for households related to the fall in home prices are roughly $4 trillion so far, and are clearly bound to increase further as home prices continue to fall –eventually reaching the $6-8 trillion range (compatible with a 30-40% fall in home prices peak to trough). With a negative wealth effect of 6 cents on the dollar, the reduction in personal consumption could amount to a whopping $500bn. And negative wealth effect from fall in equity prices – on the wake of a bleak 2009 for corporate profits – will also contribute to the contraction in personal consumption by an estimated $100bn (compatible with a 25% contraction in the stock markets).

This adjustment is consistent with a rebalancing of the economy that will over time bring the saving rate to a positive level of roughly 5-6% where it was a decade ago, for this to happen consumption has to contract by an amount close to $800bn.

Housing Sector


The 4th year of housing recession is well on course.

Total housing starts have plunged from the 2.3 million seasonally adjusted annual rate (SAAR) peak of January 2006 all the way to the 625 thousand SAAR of November 2008 (the last data point available), an all time low for the time series that started in January 1959. Single-family starts built for sale are down 75% from their Q4 2005 peak (seasonally adjusted data are not available, we performed our own seasonal adjustment).

On the demand side, new single-family home sales are down 65% from their July 2005 peak. Both demand and supply of homes are therefore still falling very sharply which does not bode well for inventories. Inventories are the mortal enemy of prices for any goods-producing sector, including housing.

Starts need to fall substantially below sales so that the excess supply in the housing market is reabsorbed. Inventories persist at record highs and the gap between one-family starts (for sale) and one-family sales (-92K annual rate in Q3 2008 according to our estimates) is at levels that cannot promote a fast work–off of inventories. To put these numbers in perspective, compare this with a measure of vacant homes for-sale-only. Vacant homes for-sale-only were at 2.2 million in Q3 2008, an all time high. In the decade between 1985 and 1995 it oscillated around 1 million units on average and 1.3 million units between 2001 and 2005. This implies that we have to deal with an excess supply that ranges between 0.9 and 1.2 million units, of which roughly 85% are single-family structures.

The sharp and unprecedented fall of starts might not have reached a bottom yet. In this economy-wide recession, weakness on the demand side is bound to persist and we believe that supply will have to fall further, given also the great wave of foreclosures that is adding to the excess of supply in the market. We see starts falling another 20% from current levels.

We believe that home prices will not bottom out until the middle of 2010. Our target is a 38% peak to trough (so far prices have fallen 25% from the peak) but given the worsening conditions on the real side of the economy, we see a meaningful chance for over-correction that would bring prices down 44% from the peak reached in the first half of 2006 (Case-Shiller is the reference index for these predictions.)

Labor Markets

With continued credit crunch and significant cut down in consumer and business spending, the monthly job losses will continue in the 400-500k and 300-400k range during the first two quarters of 2009 respectively, bringing the unemployment rate to 8% by mid-2009. The severe contraction in private demand until early 2010 will keep lay-offs high and the unemployment rate elevated over 8%.

Economy wide job cuts are expected, with big corporations and small enterprises, residential and commercial construction, financial services and manufacturing continuing to shed jobs at a strong pace. Moreover with structural shifts in the economy since the last recession, job losses this time will be more severe in the service sector, including retail, business and professional services and leisure and hospitality. Unless the fiscal stimulus addresses the deficit problem for state and local government, job losses at the government level will also gain pace. In turn, income and job losses will further push up default and delinquency rates on mortgages, consumer loans and credit cards. Moreover, the loss of high paying corporate and financial sector jobs will be a big negative for tax revenues over the next two years.

Lay-offs are bound to continue thereafter as cost-cutting gains pace with the beginning of the (sluggish) recovery period in early 2010. Even as consumer demand might show some signs of recovery, firms, like in the past, will begin by hiring only part-time and temporary workers initially. The unemployment rate might peak at close to 9% in Q1 2010, almost two years after the recession began. However, the hiring freeze across industries that began in late 2007 will continue at least until 2010 causing discouraged workers to leave the work force and containing the extent of the spike in the unemployment rate. Further, the decline in labor utilization will add to the deflationary pressure in the economy. An aging labor force, lower capital spending and potential growth over the next few years might also result in lower productivity growth and an increase in the natural rate of unemployment (NAIRU).

Capital Expenditure

Firms have been drawing down inventories beginning in Q4 2008. As the slump in domestic and foreign demand and difficulty in accessing short-term credit persist over the next four quarters, business investment is bound to contract in double-digits throughout 2009. Industrial production, spending on equipment and durable goods will also remain in red through 2009. Moreover with a sluggish recovery in private demand even during 2010, firms will start building inventories and contemplate capex plans only at a slower pace.

Trade

Exports contraction that began in late 2008 will gain pace in 2009 as more and more emerging economies slip into slowdown following the G-7 countries. On the other hand, easing oil prices and secular downward trend in consumer spending and business investment will help imports to shrink. In fact, this might cause the trade deficit to contract in 1H 2009 since the contraction in imports might well exceed the decline in exports, thus containing any negative contribution of trade to GDP growth.

Dollar Outlook

The fate of the U.S. dollar in 2009 rests on the global growth outlook. After profit-taking on long USD positions ends and trading volumes pick up as investors return from their holidays, the dollar may temporarily recover its relative safe haven status in H1 2009. Since markets have yet to fully appreciate the impact of the commodity slump and financial crisis on the rest of the world, risk appetite may collapse again on signs of a deeper- or longer-than-expected recession outside the U.S.. Further de-leveraging of USD-denominated liabilities could provide an additional boost to the dollar as a funding currency. The bond yield outlook could be a further source of strength: while the Fed is already at ZIRP, other central banks will cut rates further to stimulate growth, putting downward pressure on currencies like the Euro. Alternating with these upside risks to the dollar may be downside risks from 1) a supply crunch in commodities that lifts commodity prices and producers' economies, 2) inability of the market to absorb increased Treasury supply at low yields.

Downside risks to the dollar seem more likely to outweigh upside risks in the latter half of 2009 and in 2010. Yet at the same time, similar downside risks exist for other currencies – growing fiscal deficits will weaken a range of currencies. With emerging markets continuing to have trouble attracting capital and Asian economies, hammered by export contractions, will be reluctant to allow their currencies to appreciate against or with the dollar – China allowed some depreciation of the RMB at the recent euro-dollar peak.

Once crucial support from deleveraging wanes, however, the dollar may be left with only foreign central bank reserve accumulation, which has already waned on the reversal of capital flows, to finance the large U.S. current account deficit. Continued repatriation of assets and higher enforced domestic savings rates will at least reduce pressure on the dollar in the short-term.

Inflation/Deflation



Annual U.S. inflation, as measured by official producer and consumer price indices, is likely to slow in 2009 and even fall into technical deflation despite increases in the monetary base and fiscal measures to boost spending power. Slumping commodity prices may drag down the average annual headline CPI inflation rate to around -2% - a technical deflation which may morph into genuine deflation if falling prices generate expectations that they will continue to fall. Meanwhile, the growing slack in product and labor markets will keep core consumer inflation subdued at an average year-over-year rate of 1-2%. Steep discounts to get rid of unsold retail inventory, rising job losses and lower wage growth will reinforce the trend of stagnant or falling prices. Loose labor markets and weak demand for commodities and goods/services will keep producer prices at bay. Risks to the outlook include 1) a commodity supply crunch or geopolitical shock that leads to a sustained rise in commodity prices and 2) an earlier than expected global economic recovery.

Credit Losses Still Ahead



Back in February 2008, Nouriel Roubini warned that that the credit losses of this financial crisis would amount to at least $1 trillion and most likely closer to $2 trillion. As of mid-November 2008, the threshold of $1 trillion in global financial writedowns was finally reached. Given that national house prices expected to drop another 20%, we expect credit losses of $1.6 trillion.

An in-depth analysis of current and expected loan losses per asset class and separately of mark-to-market writedowns per securities class based on current prices indeed confirms RGE’s initial loss range estimates (outstanding loan and securities amounts as in IMF GFSR, Table 1.1) For our calculations we assume a further 20% fall in house prices, and an unemployment rate of 9%. With respect to credit losses on unsecuritized loans, recent research by the Fed Board using comparable assumptions (but assuming high oil prices) concludes that over half of 2006-2007 subprime mortgage originations are going to default (i.e. $150bn out of $300bn). The loss trajectories for Alt-A loans are similar resulting in a 25% default rate ($150bn out of $600bn). Even prime mortgage delinquencies display a very high correlation with subprime loan delinquencies, implying an approximate 7% default rate when the potential for ‘jingle mail’ is taken into account ($266bn out of $3,800bn).

The cycle has also turned in the commercial real estate (CRE) arena with the traditional lag of around 2 years. Current serious delinquency plus default rates of 5.9% of CRE loans (net recovery, via Fed data) are projected to increase to up to 17% by Fitch assuming a 25% fall in prices ($408bn out of $2.4 trillion.) In the consumer loan area, we estimate credit card charge-off rate could increase to 13% in the worst case scenario. Adding a typical 5% delinquency rate during recessions, the total loan losses on unsecuritized consumer loans are projected to increase to $252bn out of $1.4 trillion (see The U.S. Credit Card Industry in 2009, by RGE’s Mathias Kruettli.)

The IMF warned that commercial and industrial loans (C&I) charge-off and delinquency rates are likely to climb to historical peaks and potentially beyond in this cycle. Compared to past C&I loan loss rates, we project charge-off and serious delinquencies to reach 10% or $370bn out of $3.7 trillion of unsecuritized C&I loans. With regard to leveraged loans, the latest research by Boston Consulting/IESE Business School based on the 100 largest PE firms engaged in LBOs calculates an expected book loss from default of about 30%. This translates into $51bn out of $170bn unsecuritized leverage loans.

Based on these calculations, RGE expects total loan losses to reach about $1.6 trillion out of $12.4 trillion of unsecuritized loans alone, implying an aggregate default rate of over 13%. The IMF assumes that the U.S. banking system carries about 60-70% of unsecuritized loan losses (and about 30% of mark-to-market losses on securitizations). Even assuming that future loan losses are fully discounted at current market prices, deploying the remaining TARP funds towards recapitalizing the banking system would still be warranted.

The Disconnect Between Bond and Equity Markets



U.S. government bonds were on a tear in 2008, while equities plummeted in a nasty bear market. Bond yields at the long end hit all-time record lows, while the short end even dipped into negative territory. Only TIPS suffered as deflation risks rose. Stocks, on the other hand, had their worst year since the Great Depressions: DJIA lost 34%, S&P 500 -38.5%. At its 2008 low on November 20, the S&P 500 was down 49% for the year and 52% from its October 2007 peak. Stocks rallied in December though, resulting in an apparent disagreement between the stock and bond markets over the outlook for the U.S. economy. Bond markets seemed to be discounting a recession in 2009 while stock markets have been gaining since late November. This disconnect may vanish in 2009 though if the stock market rally was really just a bear market rally due to portfolio re-balancing and thin year-end trade volumes.

However, there have been intimations that the bond market is in a bubble about to burst in 2009. Indeed, with ultra low bond yields, investors may be tempted to switch into higher-yielding equities - which are now considered by many to be undervalued. Valuation, however, is not the be-all and end-all of asset performance. The credit freeze needs to end before equities can see the end of the bear market. However, considering the likely economic stagnation ahead, bonds should be a better bet than equities for some time. We see meaningful downside risks to stock prices as bad macro news – worse than expected – continues to dominate in 2009. Using the S&P 500 as benchmark, earnings per share will stay in the $50-60 range – and earnings will fall further. If, and it is not unusual during recessions, P/E ratio falls in the 12-14 range, we could see another 25% slide in stock prices.

Fiscal and Monetary Policy

Fiscal Policy

A lot of hope is being placed on the expected fiscal stimulus package of around $750 bn spread over 2009-10 including 40% of the stimulus in tax cuts for households and firms. Around half of the stimulus is expected to kick-in starting Q2 2009 and through 2010. But this will fall short of the pull-back in private demand of close to $1 trillion during this period.

Infrastructure spending, in spite of being highly effective, might not be timely, stimulating the economy only in late-2009 and 2010 when it has well passed the severe recession phase only to exacerbate the ballooning fiscal deficit. Nonetheless, around $100bn of infrastructure investment might be able to kick-in during 2009. Moreover, job creation in infrastructure might be overestimated given limitations in moving laid-off workers from other sectors to the infrastructure projects. As such, any job creation via government spending and tax incentives for firms will significantly fall short of the ongoing lay-offs.

Given the drawback of the ‘spending’ component of the stimulus, the government may be enticed to implement more tax cuts. While tax incentives for households like payroll and child tax credit might be well-targeted at the group with high propensity to spend, tax cuts in general will be less effective in stimulating demand given a secular rise in the saving rate expected over the next few years. Likewise, tax breaks for firms hiring new workers or investing in new equipment will be rather ineffective since businesses see little viability in doing so during a slump in domestic and export demand. At the most, tax stimulus in spite of being timely and well-targeted will cause only a temporary rebound in the economy for a month or a quarter merely shifting the spending decision period just like tax rebates did in 2Q 2008.

Expansion of unemployment benefits, food stamps and other incentives will have a high bang-for-buck effect in 2009 and will only assuage the impact of the recession. The stimulus will also include up to $100 bn for state and local governments to meet their severe budget shortfalls including grants, Medicaid and unemployment insurance funds, preventing cutbacks in public services, investment and jobs in several recession-hit states. But again, fiscal aid for states often suffers from time lags.

Fiscal stimulus, TARP spending, GSEs-related expenditure along with further slowdown in corporate and individual income tax revenues will push the fiscal deficit to around $1.3 trillion in FY2009.

Monetary Policy

The Fed has enacted a wide and unprecedented range of measures to mitigate the credit crisis and stimulate the economy. It has already cut its target range for the Fed funds rate down to 0-0.25% (essentially ZIRP) but, more importantly, it has created currency swap lines and an alphabet soup of programs to provide liquidity to the financial system and clean out toxic financial assets. The Fed experimented with different forms of financing itself in order to enable a sharp expansion of its balance sheet to accommodate these liquidity facilities. In addition to rate cuts and quantitative easing, the Fed has directly aided failing financial institutions. Now, the Fed is considering issuing its own debt and/or purchasing long-dated Treasuries and Agency debt. Will the monetary easing work? So far, the increase in money supply has not been accompanied by an increase in the velocity of money. In other words, credit growth remains stagnant as banks are reluctant to lend back out the money provided by the Fed and, at the same time, borrower demand has fallen.